3 Elimination of Double TaxArticle 23 – The Ultimate Destination!It casts a responsibility on Country of Residence (COR) to eliminate double tax.Title is misleading. Not just this article, but the whole of the DTA is for elimination of Double tax.

5 Elimination of Double TaxThe article applies to countries whose residents earn income in Country of Source (COS).Country of Residence (COR) exempts the income from tax, which arises in COS. [Exemption method].COR grants a deduction (credit) for tax paid in COS, against tax payable in COR. [Credit Method].

6 Elimination of Double TaxThree kinds of credits are available:- Direct tax credit.- Underlying tax credit.- Tax Sparing.The article works in combination with the Distributive Rules of the DTA, domestic tax rules. Non-discrimination article and Mutual Agreement Procedure may also be applicable.

7 Elimination of Double TaxThe article may not always eliminate double tax.Or it may also lead to double non-taxation.The manner, procedure, documents & rules for relief are left to the domestic law.

8 Elimination of Double TaxCOR is concerned with elimination of double tax. Residents have to suffer double tax.It is an outbound investment related issue - so to say.For all other articles, usually it is a COS issue.- Subject to tax.- Liable to tax.- Beneficial owner.Domestic rules can supplement the DTA.

9 Double Taxation - different kindsEconomic double taxation – same income is taxed twice in two persons’ hands.DTA does not eliminate this double taxation.Juridical double taxation – income is taxed in one person’s hands in two different jurisdictions.DTA seeks to eliminate this double taxation.9

10 Double Taxation - different kindsDual residence – Both countries may seek to tax the person on global income basis.DTA allocates residence to one country with tie-breaking rules.Dual source – the income may be considered as sourced in both countries.DTA does not eliminate this double taxation.10

11 Basic Rule – Credit MethodArticle 23B(1):Where a resident of U.K., derives income which,in accordance with the provisions of this DTA, may be taxed in India,U.K. shall allow a deduction from the tax on the income, an amount equal to tax paid in India.

12 Basic Rule – Credit MethodArticle 23B(2):Where the income derived by a resident of U.K., is exempted from tax in U.K.,U.K. can take into account the exempted income, to calculate tax on the unexempted income.

13 Credit MethodFull credit – COR gives credit for the entire tax amount paid in COS.Ordinary credit (proportionate credit) – COR gives credit for tax paid in COS, which is payable on that portion of income which is taxable in both – COR & COS.

14 Basic Rule – Exemption MethodArticle 23A(1):Where a resident of U.K., derives income which,in accordance with the provisions of the DTA may be taxed in India,U.K. shall, subject to the provisions of paragraphs 2 and 3,exempt such income from tax.

15 Basic Rule – Exemption MethodArticle 23A(2):Where a resident of U.K. derives income which,in accordance with the provisions of articles 10, 11 and 12, may be taxed in India,U.K. shall allow as a deduction from the tax of that resident an amount equal to the tax paid in India.

16 Basic Rule – Exemption MethodSuch deduction shall not exceed that part of the tax, which is attributable to such items of income derived from India.

17 Basic Rule – Exemption MethodArticle 23A(3):Where in accordance with any provision of this DTA,income derived by a resident of a U.K. is exempt from tax in U.K.,U.K. may calculate tax on the unexempted income.

18 Basic Rule – Exemption MethodArticle 23A(4):The provisions of paragraph 1 (i.e. U.K. exempts the income) shall not apply to income of a U.K. resident,where India applies the provision of DTA to exempt such income or applies concessional rate as per article 10(2) or 11.[OECD Model].18

19 Exemption MethodFull exemption – COR does not consider at all the income taxed in COS. It considers as if the resident never earned that income.Exemption with progression – COR does not tax the income taxed in COS; but considers that income for determining the tax on the unexempted income.

20 Credit MethodExemption MethodLooks at tax.Looks at income.Total Tax payable is usually equal to the higher of the rates in two countries.Tax could be lower than the rate in COR.The benefit of tax reliefs in COS are enjoyed by COR.COS can give fiscal benefits which investors can enjoy.Losses in COS are considered in COR.Losses in COS ignored.Investment Export Neutrality.Investment Import Neutrality.[See paras 18 to 23 of Model Commentary]

22 Foreign Tax Credit – Indian RulesThere are no rules for FTC.Section 91 – applicable where there is no DTA.Indian residents are given credit for doubly taxed income. Lower of foreign tax rate or Indian tax rate is available as credit.Section 90 – applicable only when there is a DTA. DTA lays down principles.

24 Foreign Tax Credit – Some judicial decisionsTax paid abroad has to be considered country-wise u/s. 91.Example Income TaxIncome & tax in Country A 1, (30%)Loss in Country BNetWhether credit will be for Rs. 300 or only Rs. 180 (30% 600)?(Bombay Burmah Trading – 259 ITR 423).

25 Foreign Tax Credit – Some judicial decisionsCredit is available for income which is doubly taxed.Income TaxSoftware income inCountry A , (20%)Income in India:Software income – 10AA 1,Other income (30%)1,Less: Tax Credit or NIL?

30 Foreign Tax – Deductible expenditureBusiness tax paid in Thailand was allowed as a deduction as it was based on turnover. It was not considered disallowable u/s. 40(a)(ii).(K.E.C. International – 256 ITR 354).

31 Foreign Tax – Deductible expenditureWhat is the meaning of income-tax?Is tax on Gross income income-tax?Is voluntary payment an income-tax?Is negotiated tax rate income-tax?Government may have to come out with guidelines.

32 Underlying Tax Credit UTC means credit for corporate tax.UTC operates only when dividends are paid.If dividends are paid by the company, the shareholder gets credit for:- Tax on dividends+- Corporate tax on profits out of which dividends are paid.

35 Underlying Tax Credit Without UTC – Cascading effect of taxes:An Indian company invests in Mauritius. Mauritian company invests in U.K. company. Dividends are declared by U.K. company which flow through to Indian company.

43 Amount of Tax Credit Singapore income of Indian resident.Profit before depreciation in Singapore. 10,00,000Less: Depreciation as per Singapore law. 1,50,000Profit after depreciation ,50,00020% ,70,000Tax as a percentage of 10,00, %

44 Amount of Tax CreditTotal Income of India resident: Profit in India – Singapore income. 10,00,000 Indian business income. 5,00,000 Total Income 15,00,000 Less: Depreciation as per Indian laws. 3,00,000 Net Profit. 12,00,000 Tax in 30%. 3,60,000 Tax as % of 15,00,000 24%

50 PE Losses III. Restriction on Double Dip: Income 60,000 1,20,000Add: Loss which is set off in India20,0001,40,00030% in COR18,00042,000Tax in India-3,000Total tax45,000Total tax in 2 years.63,000There is a tax deferral.

53 Pick and Choose U.S. Treasury Explanation – India– U.S. DTA.U.S. company has 3 sources of income in India.SourcePE StatusIncomeANo PE5,00B-300CPE exists1,000

54 Pick and Choose Can the assessee elect as under:For source A, no PE; no tax.For source B, “opt” for I.T. Act; set off the loss against source C.“Pick and choose” not permitted.Do not set off source B Loss; or offer source A also to tax.

55 Individual going AbroadExample:Individual is deputed to U.S.A. in Nov for two years.Prior to that he was an Indian resident.Nov – March, 2008 – Salary is taxable in U.S. & India.Jan. ‘08 – Mar. ‘08 – How much credit should be claimed?

56 Individual going AbroadFinal U.S. tax will be known after Dec. ‘08. [U.S. has a calendar year.]In India, return has to be filed by July, ’08.Practically, file the return on the basis of withholding taxes paid upto March. ‘08.After U.S. assessment is over, file revised return in India.May be better to pay less tax in India at the time of filing the original return.

58 Individual going AbroadU.S. taxes – Will state & city tax be available as credit?U.S. – India DTA applies only to Federal tax.Section 91 – credit is available for foreign taxes, only where there is no DTA.[U.S. residents also do not get credit of foreign tax against state & city tax.]

59 Individual going AbroadSocial security tax – Is credit available?DTA does not apply to social security tax.[OECD – social security charges means charges paid where there is a direct connection between the levy and individual benefits to be received.]Can exemption be claimed by claiming – Diversion by overriding title? – Difficult.Is credit available for Flat tax paid in foreign country?

60 Taxes Article 2 – deals with taxes covered by the DTA.Nature of tax should be income-tax.Income-tax levied in any form by any authority - is eligible for DTA relief.In some countries, only Federal Tax is eligible e.g. U.S.A.

62 Dividend Distribution Tax (DDT)Can credit be available for DDT as:- Direct Credit.- UTC.Is DDT tax on income?Can we consider that DDT has been paid by earner of income?Is it necessary that income earner should pay the tax?

63 Dividend Distribution Tax (DDT)S.115-O – Dividends shall be charged to additional income-tax.S.115-O(2) fixes the liability on the company. Thus company pays income-tax +DDT.This is a COR issue.Can DDT be considered as a part of UTC? (Article 24(1)(b) of India – U.K. DTA).

64 Dividend Distribution Tax (DDT)Article 24(1)(b): In the case of a dividend paid by a company which is a resident of India to a company which is a resident of the United Kingdom and which controls directly or indirectly at least 10 per cent of the voting power in the company paying the dividend, the credit shall take into account (in addition to any Indian tax for which credit may be allowed under the provisions of sub-paragraph (a) of this

65 Dividend Distribution Tax (DDT)paragraph) the Indian tax payable by the company in respect of the profits out of which such dividend is paid.

66 Dividend Distribution Tax (DDT)U.K. & Mauritius have clarified that they will give credit for DDT.Can DDT be restricted to DTA rate?India-U.K. DTA- Article 11(2) –Can an Advance Ruling be obtained?S.245N(a)(i) – Does the non-resident bear the tax?S.245N(a)(ii) – Is it a tax liability of the non-resident?

67 Fringe Benefits Tax Is it a tax covered under the DTA?Whose tax is being paid – Employer or Employee?Who will get the credit – Employer or Employee?[Employee may be taxed in his home country. In India, employer will pay FBT.]

68 Fringe Benefits TaxFor the employer, can we say, it is tax on income, or is it a tax on expenditure?[Even if there is a loss, FBT may be payable.]FBT may be payable without having a PE. There may be no income taxable in India, yet FBT is paid. Will it be available as credit?It is a COR issue.

69 Education CessCess means a tax for specific purpose. When levied as increment to an existing tax, the name matters not for the validity of the cess must be judged of in the same way as the validity of the tax to which it is increment.(Chaturvedi & Pithisaria, fifth edition, Page 2377.)

71 Education CessE.C. is not E.C. is part a part of I.Tax of I.Tax Tax in India on Foreign Income Add: Education Cess 9 9 Total Tax Foreign Tax – 400 Restricted to Net Tax in India 9 -

72 Timing Mismatch - ExamplesEmigrants from Australia pay capital gains tax on deemed basis as if assets have been sold on date of emigration. Will they get credit in COR when assets are actually sold?U.S.A. – Installment sale.Different meanings of accrual.

73 Timing Mismatch - ExamplesSingapore – DTA applies only to the extent income remitted to Singapore.[Thoresen Chartering – Mumbai Tribunal – June, ’08 – Tax charged at full rates if income is not remitted to Singapore]In subsequent year, if the income is remitted, will Singapore give credit for excess tax paid in India? Will India give refund?

74 Documents for Tax CreditDTA does not prescribe any documents or procedure. It is left to the domestic law.Indian Income-tax Act / Rules also do not prescribe any procedures/documents.Following documents help- Foreign TDS certificate.- Tax payment slips / challans.- Foreign tax return.- Certificate from foreign C.A.

75 Double Tax - UnrelievedA non-resident of both countries having dual source income may have unrelieved double tax.Example:A person normally resident in Singapore, is deputed to India w.e.f He gets family allowance from Jan. to Apr. ’08 as his family is in Singapore. This allowance is taxed in Singapore. Will he get credit for Singapore tax in India?

76 Checklist for Foreign Tax CreditIdentify the person – who has earned the income, & who has borne the tax?Is the tax covered under the DTA?If yes, credit available as per DTA.Are there domestic FTC rules?Is the DTA FTC limited by domestic FTC rules?

77 Checklist for Foreign Tax CreditHow much income can be considered as foreign income as per ordinary commercial principles?Determine taxable income earned abroad.Expenses attributable to foreign income should be deducted from foreign income.Apply COR rules for computing foreign income. (Can we apply S. 14A & Rule 8D?)Determine tax on doubly taxed income in COR.

78 Checklist for Foreign Tax CreditFinality of tax in COS is generally available for credit.Timing mismatches.[Practically tax credit may be available without strictly going into detailed rules.]Questions & Comments are welcome.Naresh Ajwani